The territorial dispute between China and Japan continues to stir the waters. Here to provide insight in this excerpt of On the Trading DeskSM from Friday, February 22, 2013 is special guest expert, Michael Auslin, Ph.D. He’s a scholar in Asian studies and director of Japan studies at the American Enterprise Institute.

Could you provide us with some historical context to help us understand the territorial dispute over the Senkaku islands?
Well the islands are located, Brian, just off the northeastern tip of Taiwan, and traditionally they were uninhabited and really unclaimed by any country. Of course, when you are an island nation like Japan or Taiwan, then the question becomes whether outlying and smaller islands are part of your territory or not. At the very end of the 1800s, Japan went to war with China and from that period on began what was in effect control of the islands. They didn’t claim them formally. Then at the end of World War II in the San Francisco peace treaty, Japan was given administrative control over the islands, though no one ever really thought to write down who they belonged to or not. So they remained in a gray zone. All of that began to change a few years ago as oil and gas reserves were discovered underneath the waters around the islands, and suddenly both Japan and China got much more interested in these uninhabited rocks. Surveys were done to actually determine how much oil and gas was there. Both China and Japan began to ramp up their claims that they actually owned these islands. Now, Japan still administered them, but China began to dispute the sovereignty of the islands.

And so it was last September, I think, that tension between Japan and China escalated. What happened?
What happened last September to move this story to the present crisis is that Japan decided to buy the islands owned by a private Japanese family. But that, again, didn’t mean that they were Japanese territory; they were just owned by this family. This set off massive demonstrations and anger and outrage in China. Japanese businesses were sacked. There was a boycott against Japanese goods, and most worryingly the Chinese government has been sending in maritime patrol boats and now naval vessels regularly into the waters around the islands to chip away at Japan’s claim to have administrative control. And the Japanese have countered with their Coast Guard and now their Air Force. So it’s a very, very tense situation.

What concerns me, and maybe many other Americans, is our nation’s role in this crisis. What’s going on in Washington, D.C.?
Yeah, it’s a huge issue. It’s probably the biggest thing that worries Washington. We do have a treaty with Japan that we signed back in 1960 that calls on us to come to their aid in the case of an attack. And Japan’s government has actually asked the United States whether the islands are covered. The United States has said yes, these islands do come under the security treaty. Now the question is, in what case would the United States actually come to the aid of Japan? That is what I think China and Japan and people in Washington are trying to figure out. What China has said is that because these islands are not only Chinese territory, but we are also trying to exert some administrative control, then the alliance between Japan and the United States doesn’t hold. If China can somehow create a condition where the islands are not seen as administratively controlled solely by Japan, meaning China also exerts some administrative control, then they believe America will reinterpret its commitment to Japan to protect these islands. What Washington has done has made it very clear that the United States takes no position on the sovereignty question, meaning we don’t say that these territories are Japanese or Chinese. What the government has said is that it wants the status quo to continue. But the truth is that is not the strongest statement that the United States could make. Telling smaller nations, even Japan, that they’re on their own against China emboldens China and it undercuts the resolve of these nations that want to try and protect what they consider to be their territory.

Now I am going to ask you to put on your prognosticator’s hat. How would you see things playing out for China and Japan?
I’m worried that neither side is interested in negotiating with each other and that the United States has not sent stronger signals that this is unacceptable. Not because it’s our job to protect Japanese territory, but because this is shifting the balance of power in Asia and the Pacific. Something that leads to what I think should be the greatest fear: , that someone will make a mistake or that there is going to be an accident. Two planes or ships collide, life can be lost. And then you are in a true crisis. This is what we need to be very worried about because, otherwise, we don’t see any off-ramp to this crisis.

And so what do you think needs to happen for things to go well for China and Japan?
Well, I think that if we can go for some period, let’s say three to six months, without anything happening—the Chinese decide not to send in ships and planes and the Japanese also don’t do anything to try and make their control over the islands more overt—then I think you could have a cooling down of emotions and a chance that you could move to some sort of negotiation over, at least, rules of behavior.

I would like to let our audience know that we will have another discussion on Friday, March 1, a video edition with Dr. Auslin and portfolio manager Jeffrey Everett, who invests internationally, including both China and Japan, to discuss current trade relations and investing in the region amid the turmoil. Please join us. But for now Dr. Auslin, thank you for joining us this week.
My pleasure, thanks for having me.

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